This article was originally commissioned and published in for the March 2014 edition of the Investment Life & Pensions Moneyfacts publication.
In the second of a two part series, Tom Murray suggests that the current range of life and pensions products is not sufficiently flexible to cater for the needs of the growing number of non-retirees.
Back in the January 2014 issue, I looked at how increasing longevity was changing society, particularly in terms of the way people retired or indeed didn’t retire but changed their mode of working instead of retiring. The fact that the percentage of non-retirees is likely to increase significantly over the next few decades means that the life and pensions industry’s range of products is not sufficiently flexible for this new market and will therefore require significant upgrading.
If people are no longer heading towards a cliff-face of retirement, then the complete switch from earnings to pensions is likely to become a thing of the past. In this scenario, products are required that allow flexibility in the income delivered as the income required is dependent upon the needs of the moment.
The earning capacity of the elderly is unlikely to be linear. They are more prone to illnesses that will prevent them earning at certain times during their ‘retirement’ phase. Also, it is likely that their desire to work will be competing with their desires to do other things such as travel or pursue hobbies and interests. If they were to draw income purely from a savings account, each year’s drawing would be different depending upon the level of their need and their own earning capacity during that year.
If their own earning capacity will go up and down, then it is a logical corollary that their need to draw income from pension savings will also fluctuate on a frequent basis. Therefore their first requirement of an un-retirement product is the ability be able to draw income on demand rather than to be doled out a set amount at a particular frequency.
Thus those with funds for discretionary spending need to be able to switch these funds into the provision of care, if required, or to draw on those funds directly for any other urgent need that arises, be it for emergency medical treatments or a much-needed cruise of the West Indies. Then, if that level of care or spending is no longer required, they need to be able to reduce their drawings to allow the maximum amount to stay in the market in order to maximise the growth of their assets.
Although this may seem unlikely as not many people ever come out of long-term care, short term care products would be required by some from time to time if they suffer from any condition which leaves them unable to look after themselves for a temporary period. The ability to draw on the assets that are available or to utilise those assets to support guaranteed benefits would mean that people could adjust their ability to draw on their accumulated investments based on their current circumstances.
Totality of assets
This brings us to the second key point that needs to be catered for by un-retirement products. It is the fact that the varying needs of those in their later years needs to be met from the income streams they have, of which, at this stage in their life, their salary forms but one.
Thus assets should not be shut off or dedicated to one use only but should be available to support the entirety of the needs of the elderly person and provide different income streams and guarantees at will. However, it is not currently possible to have this level of flexibility as funds accumulated in the current pensions savings regime are treated differently because of the regulatory nature of the pension savings element, which means that funds accumulated under the ‘pension’ wrapper can only to be used in very straight-jacketed circumstances. The tax-efficiency of this manner of saving is offset somewhat by the restrictions that it inevitably puts in place. The result might be generically good, in the sense that people are pushed to buy annuities and are therefore guaranteed a steady, if usually low, income for life. However, it assumes a steady, if usually low, expenditure rate, which is just not the case for anybody.
Home is where the wealth is
The third point is what can be used to provide supplementary income streams or guarantees in old age. Each individual needs to be able to draw upon all their assets as and when the need arises, and the truth still remains that for most people, the most significant asset they ever attain over their lifespan is their house. This accounts for the fact that most people are passionately attached to the property they own and are reluctant to part with it.
In terms of planning asset rundown over the period of the decades of non-retirement, say 25 years for the average punter, this, the individual’s largest asset, cannot be overlooked. Currently accessing the value of the property is achieved on a one – off basis, by using equity release products, but this product is not widely sold and is generally used in extreme circumstances such as the urgent need for an expensive level of long term care.
One of the things that frighten many people away from equity release products is the fact that they want to leave their house to their heirs. Thus, despite desperate day-to-day need, they cling onto their house grimly above all their assets. In the new era, we need to move away from this kind of thinking and to start regarding the home as just one of the assets built up over the person’s lifetime which should be used to smooth the income flow that they need in their later years.
Beneficiaries of a will see the house as just one more asset and the new era of financial products are required that view it in exactly the same light. The property value could be easily represented as a specialised fund that rises or falls with the changes of value of the market, which would make it easier to use the value to fulfil some of the needs of the individual when their income is not quite reaching the levels of their needs.
We as an industry need to ask ourselves why we differentiate so strongly between different asset classes when it comes to assessing individuals wealth and putting products in place which allow the consumer to tap into the value of their non-financial assets just as easily as they can tap into the value of their financial assets under the existing regime. Surely the type of asset is irrelevant?
The sum totals of the assets that people have accumulated during their working life is what is available to them to fund their un-retired years. And our current product set does not allow people to have the kind of flexible access to the value of their assets that would be required for the un-retired years of variable earning levels.
Perhaps in the future, the majority of houses in the UK will be brokered by the financial services sector into the market, not via repossession but via the resolution of debts outstanding after the death of the owner who had utilised the property to smooth out the financial ups and downs of their working retirement years.
The use of the taxation system to encourage saving has a distorting effect on the economy and really has no place in future product support. However, the delivery of the basic state pension provides an income stream and reduces the need to draw upon existing funds. This is the floor for the individual on top of which they should be able to draw from their un-retirement product the varying amounts required to sustain their lifestyle as both their income in retirement and their expenditure needs vary.
Aside from this, the state has no real role in the provision of support to those in non-retirement phase and should restrain from encouraging the accumulation of one type of asset class over another (e.g. pension funds over property). This will make it easier to be flexible in the use of all asset classes to supply the needs of the pensioner. For many, some of those assets will be used to buy an annuity whose income stream will raise the basic level of guaranteed income that the individual has from the BSP and will therefore reduce the need to draw upon assets as their income fluctuates.
A product based on the accumulation of all assets over a working lifetime should allow all value accumulated to be accessed by the prudent individual for the decumulation years. The ability to draw on these funds needs to be flexible to minimise the amount of time that people are ‘out of the market’ for any particular tranche of income. Therefore the ability to draw on assets, irrespective of how they were accumulated, at a time to suit the consumer appears to be the essence of what the future needs.
As there no longer is a ‘tipping point’ of retirement, there seems to be no reason why the accumulation phase should be completely separate from the decumulation phase. Therefore, another logical corollary is that the un-retirement product should allow for both accumulation and decumulation, protection and investment along with the financial representation of fixed assets that could be used to provide for more guarantees and riders. This would be a truly cradle to grave product, allowing individuals to increase their risk protection at certain phases of their life and then diminish it when it was no longer such a high priority. Income streams could be taken at various points in the consumer’s life, not just retirement and it would allow all accumulated assets to be utilised to fulfil the differing needs that the consumer would have as they move through retirement.
Power to the people
This kind of product could be topped up at any time during the retirement phase by the input of any excess income earned by the consumer or by any sudden influx of a lump sum such as a bonus or an inheritance. This would give far greater control to the individual over the years as they could invest into the product with confidence that they could draw down what they needed to when they needed to, without it being a complex scenario.
Work styles will also ensure that part-time work is catered for by either allowing the reduction in what is drawn down from the product (up to a certain limit) or the contribution of an excess of income into the product to cover any diminution of the value of the plan by investment performance or previous drawings. Guarantees could be purchased to effectively ensure that the income from the funds cannot be completely wiped out, leaving the plan owner destitute and reliant upon the state.
It seems that the working retired, or un-retired, are crying out for a product that will merge their financial assets into a single asset base from which they can draw funds and purchase guarantees that will complement their varying income and fluctuating financial needs. It remains to be seen whether the financial services sector can step up to the mark and create a product that fits the lifestyle rather than pushing people to have a lifestyle that fits their current product.
Part 1 of the 'End of Retirement' article series is also available on our blog: http://www.exaxe.com/end-of-retirement!
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